China’s Great Wall of Debt: Can it Afford Default?
Lai Xiaomin’s once glittering career ended not with the bursting of champagne corks and glowing testimonies, but with the hands of an executioner.
Once known as the god of wealth, Lai oversaw one of China’s largest and most important state-owned enterprises, Huarong Asset Management. But he died stripped of his enormous power and wealth on a dark Friday morning in late January in Tianjin, most likely via a deadly drug concoction.
Accused of corruption, embezzlement and bigamy, the 58-year-old’s unseemly demise followed three years of investigations and came just three weeks after the High People’s Court dismissed his clemency appeal.
During his trial, Lai admitted to accepting bribes totaling $ 277 million ($ 381 million) and embezzling a few more million dollars, more than anyone in the history of the Communist China.
Lai’s disappearance and the precarious state of Huarong, which was bailed out by Beijing just weeks ago after months of internal wrangling and party hall machinations, weigh on another faltering monolith, the real estate group. China Evergrande.
Founded in 1999 by Beijing in the aftermath of the Asian financial crisis, Huarong was tasked with paying off bad debts from incompetently run state-owned enterprises. Under Lai, a former banking regulator, he took steroids, expanded into investment banking and side lending, extending credit to companies that couldn’t raise funds elsewhere.
Along the way, it turned into a debt-riddled mess and a flashpoint for nervous global investors who had injected $ 23 billion ($ 32 billion) into thinking the authorities saw the bank as “too big to fail”.
Until a month ago, the day after Lai’s execution, Huarong became something of a leper in Chinese business circles. Despite his close ties to the Ministry of Finance, Huarong’s accounts were in disarray, his debt astronomical, and his bailout prospects hopeless.
Other state bodies were reluctant to participate in a rescue, fearing that they would later be blamed for the mess. And what a mess. In 2020, he lost $ 15.9 billion ($ 22 billion), wiping out all of his income since listing in Hong Kong in 2015. He wrote off a similar amount of assets.
The standoff over a bailout collapsed as looming Huarong debt maturities forced a decision.
When the State Council finally approved the bailout – which included an injection of the government-controlled conglomerate CITIC and a recapitalization – on August 18, it triggered a collective sigh of relief from investors in US and European financial centers. .
Huarong could have been the Lehman Brothers moment in China. Unlike America during the global financial crisis, Beijing surrendered.
Will China blink at Evergrande again?
This is the great chicken game. After blinking at Huarong, global markets began betting last week that Beijing would once again come to the rescue of Evergrande, the world’s most indebted real estate developer.
The company, with $ 300 billion ($ 413 billion) in debt spread among well-heeled global institutions and a vast array of small Chinese investors, has no chance of survival. And there is the not insignificant affair of the 1.6 million apartments which he sold off plan on developments which are now blocked.
Last Thursday, despite the contrary promises, he would have missed the payment on an $ 83.5 million ($ 115 million) interest bill for one of his corporate bonds. Another $ 43.5 million ($ 60 million) is due Wednesday and, bizarrely, the markets have assumed that non-payment would hasten a bailout.
They might be right. But it’s far.
There is no doubt that a total collapse of Evergrande would seriously damage the Chinese economy. But a full bailout could be just as disastrous and looks increasingly unlikely.
The Chinese real estate market is worth around $ 60 trillion ($ 83 trillion). It accounts for about 20 percent of GDP and 62 percent of household wealth.
Any major downturn in real estate would have two serious effects. Spending would be seriously affected, hitting the wider economy, which in turn would lead to increased social unrest and discontent.
Many in the ruling elite would like to avoid one or both scenarios. Others, however, clearly believe that firm action must be taken to curb debt. And President Xi Jinping seems to fall into the latter camp.
It should be noted that Evergrande’s predicament is mainly due to regulatory action from Beijing. Authorities, concerned about rampant real estate speculation, profits and a huge explosion in household and corporate debt levels, have imposed hundreds of new regulations on the industry over the past two years, including controls on the costs.
They are now starting to bite.
Property sales have fallen 14% in the past year and financing from real estate developers has halved from the same period last year, with most of the decline concentrated in the past few months.
Unless Beijing lifts its foot on the brakes, a credit crunch threatens the real estate industry from which Evergrande and other big developers will find no escape.
Chinese economy no longer obeys orders
For years, we have heard about the “inevitable rise of China” and the advantages of a controlled economy.
It’s a view that has colored the debate over our relationship with the world’s second-largest economy and, in an atmosphere of growing global hostilities, some analysts are questioning the wisdom of Australia’s decision to side with it. the United States.
But the assumptions are as questionable as the justification that you shouldn’t side with who you think might win in a showdown.
Even if you disregard China’s undemocratic political structure and human rights issues, the idea that you can just follow a straight line on China’s phenomenal growth so far and the extrapolating into the future is naÃ¯ve in the extreme.
The Chinese economy is experiencing serious growth difficulties. And for the first time, he has to face a future where there are no longer easy gains to be had.
Even on official figures, its debt to GDP ratio last year reached 270 percent, down from 246 percent the year before. These estimates are likely to be underdeveloped, as most of the domestic debt comes from public or state-controlled financial institutions that do not correctly record loans.
China trapped in middle income
Many of China’s early gains, which led to the fastest economic transformation in history, were the result of economic liberalization; simply allowing businesses and individuals to engage in capitalism. And until a decade ago, China was aided by a benevolent West which, under the banner of globalization and free trade, fostered a massive transfer of industries and wealth.
This global attitude has changed. The workforce in developed countries will no longer tolerate lower wages and job insecurity as entire industries retreat overseas.
Even without this change, China would now face what is commonly referred to as the âmiddle income trap,â where it is becoming increasingly difficult to sustain growth momentum.
China’s growing wealth led to increased income, and many large companies sought cheaper places. About 40,000 factories closed each year in China as manufacturers move to places like Vietnam, shutting down job opportunities, especially for young people.
Engineering new avenues to wealth is difficult enough. For China, it is even more difficult after more than a decade of expensive and ineffective stimulus measures, mainly focused on housing and infrastructure.
This route is no longer affordable. But every time Beijing tries to turn off the stimulus taps, the economy crumbles. Each time, he was forced to backtrack, injecting even more stimulants to start a recovery.
It’s one of those times. Does it allow Evergrande to implode, plunging millions of people into poverty, misery and unemployment? Or is it saving rich local investors at the expense of global investors and is it risking being financially isolated? Or does he just raise his hands, save Evergrande, and push the problem further?
There are no easy answers. Just as there is no “inevitable rise”.